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The Wealth Of The Nation
The most influential economist in the United States talks about prudence, productivity, and the pursuit of liquidity in the light of the past
December 1982 | Volume 34, Issue 1
I would not characterize the change in those terms. Here is what I mean: In the fifties and the early sixties the dominant individual in the business corporation was usually the one who understood operations of the business—the manufacturing process, marketing, production, distribution, and so on. Finance, in the corporate structure, ranked relatively low in influence. In recent times, however, the financial aspect of business has become increasingly important. In personal financial affairs in the fifties and sixties, the savings pattern was stable. People didn’t rush around deciding whether to invest in money market funds or in Treasury bills or commercial paper. People were not preoccupied with this. Nevertheless, economic life produced generally good results for both business and householders. Today, American industry is under pressure, and our personal activities as savers and investors are occupying much more of our time, with less rewarding results.
Doesn’t this hurt us as a country? Like lawyers, financial people don’t contribute to the efficiency of the product.
Yes, I have always believed that financial people are not innovators of products. Financial people quickly follow the productive innovative process in the real world, but they don’t engineer it. We are middlemen. Incidentally, there has always been an aspect of the history of American finance that has fascinated me: Somehow the business world dealt with the financial world at arm’s length. Many business leaders were not intimate with the financial world. They went to the financial world whenever they needed money, but otherwise the relationship was distant and formal. I think that was a good relationship. Now we have a much greater intimacy between the financial world and the business world, and we’re moving more toward the European pattern, where the financial world has much greater influence on the business world. In Europe, it’s direct. For example, the German banks are both lenders and equity holders. In the United States the pattern is more subtle. The volume of lending to business corporations is increasing. Debt is increasing more rapidly than equity. Therefore, the relationship of the creditor to the debtor is becoming closer. In addition, most of the huge volume of commercial banks’ loans to business corporations is being rolled over.
And nobody ever says, “Now pay it back.”
It isn’t self-liquida ting as it used to be. That is, the loans aren’t gradually being paid back. And because they are not self-liquidating, the relationship between borrower and lender becomes closer.
You mean the bank really becomes a part owner of the business?
Well, we aren’t quite there yet, but in some instances the banker has become a part owner even though the credit instrument is called a debt obligation. At some point, when the credit quality of the company deteriorates enough, the new role of the lender as an owner becomes more evident.
What is the harm in it?
The great discipline in our system has been the existence of two markets in our credit structure—the open credit market and the negotiated market. The open credit market consists of marketable securities—bonds, stocks, commercial paper, and the like. The negotiated market involves the direct relationship of lenders and borrowers. The American credit structure provides a sort of check and balance. In this system you can very quickly spot a deterioration of credit. For example, if there are bonds outstanding, one can watch how those bonds trade in the secondary market. Most bonds carry a credit rating, and even if the credit rating isn’t lowered quickly enough, one can sense by the way that obligation trades whether that credit rating is going to break or not.
What you’re saying is that the markets judge how good the credit is. They sell the bonds down if credit quality is deteriorating so that the price of the bonds drops?
Yes. So you have a disciplinary force working. On the other hand, if there is only a direct relationship with lenders, then that discipline isn’t there. It isn’t visible to everyone. It is important to preserve both the open and the negotiated credit markets—for the benefit of both lender and borrower. For a long time the markets in stocks, bonds, and commercial paper were a source of liquidity—cash—for commercial banks and other institutional lenders.
I’ve got a footnote question to this and I haven’t seen the answer anyplace. And that is this visibility of the discipline. If the corporation sees that its bonds are being marked down in the marketplace or one of the rating agencies marks down its bonds, then a director or a shareholder is likely to ask a question. Money will cost us more, and you have this disciplining force that you talked about, whereas if you just keep going back to the bank, they’re cozy with you, you’re cozy with them, and they’re glad to lend you more money. But don’t the Japanese have a very high ratio of debt?
Yes, they do.
And they’re certainly cozy with their banks, and yet their businesses seem to keep their operating leanness even without this discipline.